ATMOS ENERGY CORP.

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q


(Mark One)
þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended March 31, 2006
or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from to

Commission File Number 1-10042

Atmos Energy Corporation

(Exact name of registrant as specified in its charter)


Texas and Virginia		75-1743247
(State or other jurisdiction of incorporation or organization)		(IRS employer identification no.)

Three Lincoln Centre, Suite 1800 5430 LBJ Freeway, Dallas, Texas (Address of principal executive offices)		75240 (Zip code)

(972) 934-9227
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “Accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Number of shares outstanding of each of the issuer’s classes of common stock, as of April 28, 2006.


Class		Shares Outstanding

No Par Value		81,151,592

TABLE OF CONTENTS


GLOSSARY OF KEY TERMS
PART 1. FINANCIAL INFORMATION
	Item 1. Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
PART II. OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 6. Exhibits
SIGNATURES
EXHIBITS INDEX
Computation of Ratio of Earnings to Fixed Charges
Letter Regarding Unaudited Interim Financial Information
Certification Pursuant to Rule 13a-14(a)/15d-14(a)
Certification Pursuant to Section 1350

GLOSSARY OF KEY TERMS


AEH		Atmos Energy Holdings, Inc.
AEM		Atmos Energy Marketing, LLC
AES		Atmos Energy Services, LLC
APB		Accounting Principles Board
APS		Atmos Pipeline and Storage, LLC
Bcf		Billion cubic feet
FASB		Financial Accounting Standards Board
FERC		Federal Energy Regulatory Commission
FIN		FASB Interpretation
Fitch		Fitch Ratings, Ltd.
GPSC		Georgia Public Service Commission
GRIP		Gas Reliability Infrastructure Program
KPSC		Kentucky Public Service Commission
LGS		Louisiana Gas Service Company and LGS Natural Gas Company, which were acquired July 1, 2001
LPSC		Louisiana Public Service Commission
Mcf		Thousand cubic feet
MMcf		Million cubic feet
Moody’s		Moody’s Investors Services, Inc.
MPSC		Mississippi Public Service Commission
NYMEX		New York Mercantile Exchange, Inc.
RRC		Railroad Commission of Texas
RSC		Rate Stabilization Clause
S&P		Standard & Poor’s Corporation
SEC		United States Securities and Exchange Commission
SFAS		Statement of Financial Accounting Standards
TRA		Tennessee Regulatory Authority
TXU Gas		TXU Gas Company, which was acquired on October 1, 2004
WNA		Weather Normalization Adjustment

PART 1. FINANCIAL INFORMATION


Item 1.	*Financial Statements*

ATMOS ENERGY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS


	March 31,			September 30,
	2006			2005
	(Unaudited)
	(In thousands, except
	share data)

ASSETS
Property, plant and equipment	$	4,943,329		$	4,765,610
Less accumulated depreciation and amortization		1,432,287			1,391,243

Net property, plant and equipment		3,511,042			3,374,367
Current assets
Cash and cash equivalents		48,899			40,116
Cash held on deposit in margin account		13,537			80,956
Accounts receivable, net		793,019			454,313
Gas stored underground		440,946			450,807
Other current assets		195,412			238,238

Total current assets		1,491,813			1,264,430
Goodwill and intangible assets		737,495			737,787
Deferred charges and other assets		256,701			276,943

	$	5,997,051		$	5,653,527


CAPITALIZATION AND LIABILITIES
Shareholders’ equity
Common stock, no par value (stated at $.005 per share); 200,000,000 shares authorized; issued and outstanding: March 31, 2006 — 81,077,197 shares; September 30, 2005 — 80,539,401 shares	$	405		$	403
Additional paid-in capital		1,447,734			1,426,523
Retained earnings		287,727			178,837
Accumulated other comprehensive loss		(29,575	)		(3,341	)

Shareholders’ equity		1,706,291			1,602,422
Long-term debt		2,181,120			2,183,104

Total capitalization		3,887,411			3,785,526
Current liabilities
Accounts payable and accrued liabilities		708,134			461,314
Other current liabilities		380,026			503,368
Short-term debt		262,315			144,809
Current maturities of long-term debt		3,308			3,264

Total current liabilities		1,353,783			1,112,755
Deferred income taxes		287,841			292,207
Regulatory cost of removal obligation		275,209			263,424
Deferred credits and other liabilities		192,807			199,615

	$	5,997,051		$	5,653,527

See accompanying notes to condensed consolidated financial statements

ATMOS ENERGY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME


	Three Months Ended
	March 31
	2006			2005
	(Unaudited)
	(In thousands, except
	per share data)

Operating revenues
Utility segment	$	1,447,620		$	1,235,377
Natural gas marketing segment		818,629			512,891
Pipeline and storage segment		45,483			45,546
Other nonutility segment		1,595			1,278
Intersegment eliminations		(279,481	)		(110,007	)

		2,033,846			1,685,085
Purchased gas cost
Utility segment		1,131,885			912,309
Natural gas marketing segment		774,652			501,731
Pipeline and storage segment		211			4,407
Other nonutility segment		—			—
Intersegment eliminations		(278,305	)		(109,256	)

		1,628,443			1,309,191

Gross profit		405,403			375,894
Operating expenses
Operation and maintenance		112,698			103,420
Depreciation and amortization		47,076			45,326
Taxes, other than income		64,796			54,967

Total operating expenses		224,570			203,713

Operating income		180,833			172,181
Miscellaneous (expense) income		(2,439	)		958
Interest charges		35,492			33,073

Income before income taxes		142,902			140,066
Income tax expense		54,106			51,564

Net income	$	88,796		$	88,502

Basic net income per share	$	1.10		$	1.12

Diluted net income per share	$	1.10		$	1.11

Cash dividends per share	$	0.315		$	0.310

Weighted average shares outstanding:
Basic		80,573			79,270

Diluted		81,040			79,760

See accompanying notes to condensed consolidated financial statements

ATMOS ENERGY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME


	Six Months Ended
	March 31
	2006			2005
	(Unaudited)
	(In thousands, except
	per share data)

Operating revenues
Utility segment	$	2,852,630		$	2,149,058
Natural gas marketing segment		1,920,474			1,006,692
Pipeline and storage segment		85,195			89,236
Other nonutility segment		3,087			2,637
Intersegment eliminations		(543,720	)		(193,914	)

		4,317,666			3,053,709
Purchased gas cost
Utility segment		2,256,714			1,568,679
Natural gas marketing segment		1,850,178			968,688
Pipeline and storage segment		211			10,628
Other nonutility segment		—			—
Intersegment eliminations		(541,430	)		(192,283	)

		3,565,673			2,355,712

Gross profit		751,993			697,997
Operating expenses
Operation and maintenance		220,915			214,197
Depreciation and amortization		90,336			89,323
Taxes, other than income		110,212			93,622

Total operating expenses		421,463			397,142

Operating income		330,530			300,855
Miscellaneous (expense) income		(1,991	)		1,343
Interest charges		71,681			65,615

Income before income taxes		256,858			236,583
Income tax expense		97,035			88,482

Net income	$	159,823		$	148,101

Basic net income per share	$	1.99		$	1.92

Diluted net income per share	$	1.98		$	1.90

Cash dividends per share	$	0.63		$	0.62

Weighted average shares outstanding:
Basic		80,444			77,290

Diluted		80,911			77,769

See accompanying notes to condensed consolidated financial statements

ATMOS ENERGY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


	Six Months Ended
	March 31
	2006			2005
	(Unaudited)
	(In thousands)

Cash Flows From Operating Activities
Net income	$	159,823		$	148,101
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization:
Charged to depreciation and amortization		90,336			89,323
Charged to other accounts		334			477
Deferred income taxes		58,199			42,605
Other		7,587			3,315
Net assets/liabilities from risk management activities		(24,041	)		20,247
Net change in operating assets and liabilities		(143,847	)		96,025

Net cash provided by operating activities		148,391			400,093
Cash Flows From Investing Activities
Capital expenditures		(213,230	)		(137,466	)
Acquisitions		—			(1,912,532	)
Other, net		(2,842	)		(1,957	)

Net cash used in investing activities		(216,072	)		(2,051,955	)
Cash Flows From Financing Activities
Net increase in short-term debt		117,506			—
Net proceeds from issuance of long-term debt		—			1,385,847
Repayment of long-term debt		(2,162	)		(3,849	)
Settlement of Treasury lock agreements		—			(43,770	)
Cash dividends paid		(50,933	)		(49,211	)
Issuance of common stock		12,053			26,025
Net proceeds from equity offering		—			382,014

Net cash provided by financing activities		76,464			1,697,056

Net increase in cash and cash equivalents		8,783			45,194
Cash and cash equivalents at beginning of period		40,116			201,932

Cash and cash equivalents at end of period	$	48,899		$	247,126

See accompanying notes to condensed consolidated financial statements

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

March 31, 2006


1.	Nature of Business

Atmos Energy Corporation (“Atmos” or “the Company”) and its subsidiaries are engaged primarily in the natural gas utility business as well as other natural gas nonutility businesses. Our natural gas utility business distributes natural gas through sales and transportation arrangements to approximately 3.2 million residential, commercial, public authority and industrial customers throughout our seven regulated natural gas utility divisions, in the service areas described below:


Division		Service Area

Atmos Energy Colorado-Kansas Division		Colorado, Kansas, Missouri ⁽¹⁾
Atmos Energy Kentucky Division		Kentucky
Atmos Energy Louisiana Division		Louisiana
Atmos Energy Mid-States Division		Georgia ⁽¹⁾ , Illinois ⁽¹⁾ , Iowa ⁽¹⁾ , Missouri ⁽¹⁾ , Tennessee, Virginia ⁽¹⁾
Atmos Energy Mid-Tex Division		Texas, including the Dallas/Fort Worth metropolitan area
Atmos Energy Mississippi Division		Mississippi
Atmos Energy West Texas Division		West Texas


⁽¹⁾		Denotes locations where we have more limited service areas.

Our nonutility businesses operate in 22 states and include our natural gas marketing operations, pipeline and storage operations and other nonutility operations. These operations are either organized under or managed by Atmos Energy Holdings, Inc. (AEH), which is wholly-owned by the Company.

Our natural gas marketing operations are managed by Atmos Energy Marketing, LLC (AEM), which is wholly-owned by AEH. AEM provides a variety of natural gas management services to municipalities, natural gas utility systems and industrial natural gas customers, primarily in the southeastern and midwestern states and to our Kentucky, Louisiana and Mid-States utility divisions. These services consist primarily of furnishing natural gas supplies at fixed and market-based prices, contract negotiation and administration, load forecasting, gas storage acquisition and management services, transportation services, peaking sales and balancing services, capacity utilization strategies and gas price hedging through the use of derivative instruments.

Our pipeline and storage business includes the regulated operations of our Atmos Pipeline — Texas Division, a division of Atmos Energy Corporation, and the nonregulated operations of Atmos Pipeline and Storage, LLC (APS), which is wholly-owned by AEH. The Atmos Pipeline — Texas Division transports natural gas to our Atmos Energy Mid-Tex Division and to third parties, as well as manages five underground storage reservoirs in Texas. Through APS, we own or have an interest in underground storage fields in Kentucky and Louisiana. We also use these storage facilities to reduce the need to contract for additional pipeline capacity to meet customer demand during peak periods.

Our other nonutility businesses consist primarily of the operations of Atmos Energy Services, LLC (AES) and Atmos Power Systems, Inc., which are each wholly-owned by AEH. Through AES, we provide natural gas management services to our utility operations, other than the Mid-Tex Division. These services include aggregating and purchasing gas supply, arranging transportation and storage logistics and ultimately delivering the gas to our utility service areas at competitive prices in exchange for revenues that are equal to the costs incurred to provide these services. Through Atmos Power Systems, Inc., we construct gas-fired electric peaking power-generating plants and associated facilities and may enter into agreements to either lease or sell these plants.

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


2.	Unaudited Interim Financial Information

In the opinion of management, all material adjustments (consisting of normal recurring accruals) necessary for a fair presentation have been made to the unaudited consolidated interim-period financial statements. These consolidated interim-period financial statements and notes are condensed as permitted by the instructions to Form 10-Q and should be read in conjunction with the audited consolidated financial statements of Atmos Energy Corporation in its Annual Report on Form 10-K for the fiscal year ended September 30, 2005. Because of seasonal and other factors, the results of operations for the three and six-month periods ended March 31, 2006 are not indicative of expected results of operations for the full 2006 fiscal year, which ends September 30, 2006.

Basis of Comparison

Certain prior-period amounts have been reclassified to conform with the current year’s presentation.

Significant accounting policies

Our accounting policies are described in Note 2 to our Annual Report on Form 10-K for the year ended September 30, 2005. Except for the Company’s adoption of Statement of Financial Accounting Standards (SFAS) 123 (revised), Share-Based Payment , discussed below, there were no significant changes to our accounting policies during the six months ended March 31, 2006.

Additionally, during the second quarter of fiscal 2006, we completed our annual goodwill impairment assessment. Based on the assessment performed, our goodwill was not considered to be impaired.

Stock-based compensation plans

Our 1998 Long-Term Incentive Plan provides for the granting of incentive stock options, non-qualified stock options, stock appreciation rights, bonus stock, time-lapse restricted stock, performance-based restricted stock units and stock units to officers and key employees. Non-employee directors are also eligible to receive stock-based compensation under the 1998 Long-Term Incentive Plan. The objectives of this plan include attracting and retaining the best personnel, providing for additional performance incentives and promoting our success by providing employees with the opportunity to acquire our common stock.

On October 1, 2005, the Company adopted SFAS 123 (revised), Share-Based Payment (SFAS 123(R)). This standard revises SFAS 123, Accounting for Stock-Based Compensation and supersedes Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees. Under SFAS 123(R), the Company is required to measure the cost of employee services received in exchange for stock options and similar awards based on the grant-date fair value of the award and recognize this cost in the income statement over the period during which an employee is required to provide service in exchange for the award.

We adopted SFAS 123(R) using the modified prospective method. Under this transition method, stock-based compensation expense for the three and six months ended March 31, 2006 included: (i) compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of October 1, 2005, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123; and (ii) compensation expense for all stock-based compensation awards granted subsequent to October 1, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). We recognize compensation expense on a straight-line basis over the requisite service period of the award. The impact of adoption on total stock-based compensation expense included in our statement of income for the three and six months ended March 31, 2006 was $0.3 million and $0.4 million and was recorded as a component of operation and maintenance expense. In accordance with the modified prospective method, financial results for prior periods have not been restated.

Prior to October 1, 2005, we accounted for these plans under the intrinsic-value method described in APB Opinion 25, as permitted by SFAS 123. Under this method, no compensation cost for stock options was recognized

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

for stock-option awards granted at or above fair-market value. Awards of restricted stock were valued at the market price of the Company’s common stock on the date of grant. The unearned compensation was amortized as a component of operation and maintenance expense over the vesting period of the restricted stock.

Total stock-based compensation expense for the three and six months ended March 31, 2006 was $0.8 million and $2.2 million as compared to $0.7 million and $1.5 million for the three and six months ended March 31, 2005. Had compensation expense for our stock-based awards been recognized as prescribed by SFAS 123, our net income and earnings per share for the three and six months ended March 31, 2005 would have been impacted as shown in the following table:


	Three Months Ended			Six Months Ended
	March 31, 2005			March 31, 2005
	(In thousands, except per share data)

Net income — as reported	$	88,502		$	148,101
Restricted stock compensation expense included in income, net of tax		469			962
Total stock-based employee compensation expense determined under fair-value- based method for all awards, net of taxes		(684	)		(1,427	)

Net income — pro forma	$	88,287		$	147,636

Earnings per share:
Basic earnings per share — as reported	$	1.12		$	1.92

Basic earnings per share — pro forma	$	1.11		$	1.91

Diluted earnings per share — as reported	$	1.11		$	1.90

Diluted earnings per share — pro forma	$	1.11		$	1.90

Regulatory assets and liabilities

We record certain costs as regulatory assets in accordance with SFAS 71, Accounting for the Effects of Certain Types of Regulation , when future recovery through customer rates is considered probable. Regulatory liabilities are recorded when it is probable that revenues will be reduced for amounts that will be credited to customers through the ratemaking process. Substantially all of our regulatory assets are recorded as a component of deferred charges and substantially all of our regulatory liabilities are recorded as a component of deferred credits and other liabilities. Deferred gas costs are recorded either in other current assets or liabilities and the regulatory cost of removal obligation is separately reported.

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Significant regulatory assets and liabilities as of March 31, 2006 and September 30, 2005 included the following:


	March 31,		September 30,
	2006		2005
	(In thousands)

Regulatory assets:
Merger and integration costs, net	$	8,980	$	9,150
Deferred gas cost		108,130		38,173
Environmental costs		1,268		1,357
Rate case costs		9,256		11,314
Deferred franchise fees		142		6,710
Other		9,019		9,313

	$	136,795	$	76,017

Regulatory liabilities:
Deferred gas costs	$	29,258	$	134,048
Regulatory cost of removal obligation		286,894		274,989
Deferred income taxes, net		3,185		3,185
Other		7,075		8,084

	$	326,412	$	420,306

Currently authorized rates do not include a return on certain of our merger and integration costs; however, we recover the amortization of these costs. Merger and integration costs, net, are generally amortized on a straight-line basis over estimated useful lives ranging up to 20 years. Environmental costs have been deferred to be included in future rate filings in accordance with rulings received from various regulatory commissions.

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Comprehensive income

The following table presents the components of comprehensive income, net of related tax, for the three and six-month periods ended March 31, 2006 and 2005:


	Three Months Ended					Six Months Ended
	March 31					March 31
	2006			2005		2006			2005
	(In thousands)

Net income	$	88,796		$	88,502	$	159,823		$	148,101
Unrealized holding gains on investments, net of tax expense of $294 and $80 for the three months ended March 31, 2006 and 2005 and of $542 and $729 for the six months ended March 31, 2006 and 2005		479			132		884			1,189
Amortization and unrealized losses on interest rate hedging transactions, net of tax expense (benefit) of $527 and $527 for the three months ended March 31, 2006 and 2005 and $1,055 and $(2,718) for the six months ended March 31, 2006 and 2005		861			861		1,721			(4,435	)
Net unrealized gains (losses) on commodity hedging transactions, net of tax expense (benefit) of $(2,927) and $7,915 for the three months ended March 31, 2006 and 2005 and $(17,676) and $3 for the six months ended March 31, 2006 and 2005		(4,776	)		12,913		(28,839	)		5

Comprehensive income	$	85,360		$	102,408	$	133,589		$	144,860

Accumulated other comprehensive loss, net of tax, as of March 31, 2006 and September 30, 2005 consisted of the following unrealized gains (losses):


	March 31,			September 30,
	2006			2005
	(In thousands)

Accumulated other comprehensive loss:
Unrealized holding gains on investments	$	1,568		$	684
Treasury lock agreements		(22,261	)		(23,982	)
Cash flow hedges		(8,882	)		19,957

	$	(29,575	)	$	(3,341	)

Recent accounting pronouncements

In March 2005, the Financial Accounting Standards Board (FASB) issued Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations (FIN 47), which clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation when the obligation is incurred — generally upon acquisition, construction or development and/or through the normal operation of the asset, if the fair value of the liability can be reasonably estimated. A conditional asset retirement obligation is a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Uncertainty about the timing and/or method of settlement is required to be factored into the measurement of the liability when sufficient information exists. FIN 47 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

obligation. We will be required to apply the provisions of FIN 47 by September 30, 2006. We are currently evaluating the impact that FIN 47 may have on our financial position, results of operations and cash flows.

In February 2006, the FASB issued SFAS 155, Accounting for Certain Hybrid Financial Instruments , which amends SFAS 133, Accounting for Derivative Instruments and Hedging Activities and SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS 155 (a) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, (b) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133, (c) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, (d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives and (e) amends SFAS 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS 155 is effective for all financial instruments acquired or issued by us after October 1, 2006 and is not expected to have a material impact on our financial position, results of operations and cash flows.

In March 2006, the FASB issued SFAS 156, Accounting for Servicing Financial Assets , which amends SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS 156 (a) revises guidance on when a servicing asset and servicing liability should be recognized, (b) requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable, (c) permits an entity to choose to measure servicing assets and servicing liabilities under the amortization method or fair value measurement method, (d) at initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities for securities which are identified as offsetting the exposure to changes in the fair value of servicing assets or liabilities that the servicer elects to subsequently measure at fair value and (e) requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional footnote disclosure. We will be required to apply the provisions of SFAS 156 beginning October 1, 2006 but such application is not expected to have a material impact on our financial position, results of operations and cash flows.


3.	Derivative Instruments and Hedging Activities

We conduct risk management activities through both our utility and natural gas marketing segments. We record our derivatives as a component of risk management assets and liabilities, which are classified as current or noncurrent other assets or liabilities based upon the anticipated settlement date of the underlying derivative. Our determination of the fair value of these derivative financial instruments reflects the estimated amounts that we would receive or pay to terminate or close the contracts at the reporting date, taking into account the current unrealized gains and losses on open contracts. In our determination of fair value, we consider various factors, including closing exchange and over-the-counter quotations, time value and volatility factors underlying the contracts. Effective October 1, 2005, the Company changed its mark to market measurement from Inside FERC to Gas Daily to better reflect the prices of our physical commodity. This change did not have a material impact on our financial position on the date of adoption.

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following table shows the fair values of our risk management assets and liabilities by segment at March 31, 2006 and September 30, 2005:


				Natural Gas
	Utility			Marketing			Total
	(In thousands)

March 31, 2006:
Assets from risk management activities, current	$	13,419		$	15,977		$	29,396
Assets from risk management activities, noncurrent		—			—			—
Liabilities from risk management activities, current		(1,067	)		(17,530	)		(18,597	)
Liabilities from risk management activities, noncurrent		—			(1,861	)		(1,861	)

Net assets (liabilities)	$	12,352		$	(3,414	)	$	8,938

September 30, 2005:
Assets from risk management activities, current	$	93,310		$	14,603		$	107,913
Assets from risk management activities, noncurrent		—			735			735
Liabilities from risk management activities, current		—			(61,920	)		(61,920	)
Liabilities from risk management activities, noncurrent		—			(15,316	)		(15,316	)

Net assets (liabilities)	$	93,310		$	(61,898	)	$	31,412

Utility Hedging Activities

We use a combination of storage, fixed physical contracts and fixed financial contracts to partially insulate us and our customers against gas price volatility during the winter heating season. Because the gains or losses of financial derivatives used in our utility segment ultimately will be recovered through our rates, current period changes in the assets and liabilities from these risk management activities are recorded as a component of deferred gas costs in accordance with SFAS 71, Accounting for the Effects of Certain Types of Regulation. Accordingly, there is no earnings impact to our utility segment as a result of the use of financial derivatives. Our utility hedging activities also include the cost of our Treasury lock agreements which are described in further detail below.

Nonutility Hedging Activities

AEM manages its exposure to the risk of natural gas price changes through a combination of storage and financial derivatives, including futures, over-the-counter and exchange-traded options and swap contracts with counterparties. Our financial derivative activities include fair value hedges to offset changes in the fair value of our natural gas inventory and cash flow hedges to offset anticipated purchases and sales of gas in the future. AEM also utilizes basis swaps and other non-hedge derivative instruments to manage its exposure to market volatility.

For the three and six-month periods ended March 31, 2006, the change in the deferred hedging position in accumulated other comprehensive loss was attributable to decreases in future commodity prices relative to the commodity prices stipulated in the derivative contracts, and the recognition for the six months ended March 31, 2006 of $8.2 million in net deferred hedging gains ($7.1 million in net deferred hedging losses during the three months ended March 31, 2006) in net income when the derivative contracts matured according to their terms. The net deferred hedging loss associated with open cash flow hedges remains subject to market price fluctuations until the positions are either settled under the terms of the hedge contracts or terminated prior to settlement. Substantially all of the deferred hedging balance as of March 31, 2006 is expected to be recognized in net income in fiscal 2006 along with the corresponding hedged purchases and sales of natural gas.

Under our risk management policies, we seek to match our financial derivative positions to our physical storage positions as well as our expected current and future sales and purchase obligations to maintain no open

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

positions at the end of each trading day. The determination of our net open position as of any day, however, requires us to make assumptions as to future circumstances, including the use of gas by our customers in relation to our anticipated storage and market positions. Because the price risk associated with any net open position at the end of each day may increase if the assumptions are not realized, we review these assumptions as part of our daily monitoring activities. We may also be affected by intraday fluctuations of gas prices, since the price of natural gas purchased or sold for future delivery earlier in the day may not be hedged until later in the day. At times, limited net open positions related to our existing and anticipated commitments may occur. At the close of business on March 31, 2006, AEH had a net open position (including existing storage) of 0.3 Bcf.

Treasury Activities

During fiscal 2004, we entered into four Treasury lock agreements to fix the Treasury yield component of the interest cost of financing associated with the anticipated issuance of $875 million of long-term debt in October 2004. We designated these Treasury lock agreements as cash flow hedges of an anticipated transaction. These Treasury lock agreements were settled in October 2004 with a net $43.8 million payment to the counterparties. This payment was recorded in accumulated other comprehensive loss and is being recognized as a component of interest expense over a period of five to ten years. During the three and six-month periods ended March 31, 2006, we recognized approximately $1.4 million and $2.8 million of this amount as a component of interest expense.


4.	Debt

Long-term debt

Long-term debt at March 31, 2006 and September 30, 2005 consisted of the following:


	March 31,			September 30,
	2006			2005
	(In thousands)

Unsecured floating rate Senior Notes, due October 2007	$	300,000		$	300,000
Unsecured 4.00% Senior Notes, due 2009		400,000			400,000
Unsecured 7.375% Senior Notes, due 2011		350,000			350,000
Unsecured 10% Notes, due 2011		2,303			2,303
Unsecured 5.125% Senior Notes, due 2013		250,000			250,000
Unsecured 4.95% Senior Notes, due 2014		500,000			500,000
Unsecured 5.95% Senior Notes, due 2034		200,000			200,000
Medium term notes
Series A, 1995-2, 6.27%, due 2010		10,000			10,000
Series A, 1995-1, 6.67%, due 2025		10,000			10,000
Unsecured 6.75% Debentures, due 2028		150,000			150,000
First Mortgage Bonds
Series P, 10.43% due 2013		8,750			10,000
Other term notes due in installments through 2013		6,927			7,839

Total long-term debt		2,187,980			2,190,142
Less:
Original issue discount on unsecured senior notes and debentures		(3,552	)		(3,774	)
Current maturities		(3,308	)		(3,264	)

	$	2,181,120		$	2,183,104

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Our unsecured floating rate debt bears interest at a rate equal to the three-month LIBOR rate plus 0.375 percent per year. At March 31, 2006, the interest rate on our floating rate debt was 4.975 percent.

Short-term debt

At March 31, 2006 and September 30, 2005, there was $262.3 million and $144.8 million outstanding under our commercial paper program and bank credit facilities.

Credit facilities

We maintain both committed and uncommitted credit facilities. Borrowings under our uncommitted credit facilities are made on a when-and-as-needed basis at the discretion of the banks. Our credit capacity and the amount of unused borrowing capacity are affected by the seasonal nature of the natural gas business and our short-term borrowing requirements, which are typically highest during colder winter months. Our working capital needs can vary significantly due to changes in the price of natural gas and the increased gas supplies required to meet customers’ needs during periods of cold weather.

Committed credit facilities

As of March 31, 2006, we had three short-term committed revolving credit facilities totaling $918 million. The first facility is a three-year unsecured facility, expiring October 2008, for $600 million that bears interest at a base rate or at the LIBOR rate plus from 0.40 percent to 1.00 percent, based on the Company’s credit ratings, and serves as a backup liquidity facility for our $600 million commercial paper program. At March 31, 2006, there was $262.3 million outstanding under our commercial paper program.

We have a second unsecured facility in place which is a 364-day facility expiring November 2006, for $300 million that bears interest at a base rate or the LIBOR rate plus from 0.40 percent to 1.00 percent, based on the Company’s credit ratings. At March 31, 2006, there were no borrowings under this facility.

We have a third unsecured facility in place for $18 million that bears interest at the Federal Funds rate plus 0.5 percent. This facility expired on March 31, 2006 and was renewed effective April 1, 2006 for one year with no material changes to its terms and pricing. There were no borrowings outstanding under this facility at March 31, 2006.

The availability of funds under our credit facilities is subject to conditions specified in the respective credit agreements, all of which we currently meet. These conditions include our compliance with financial covenants and the continued accuracy of representations and warranties contained in these agreements. We are required by the financial covenants in both our $600 million three-year credit facility and $300 million 364-day credit facility to maintain, at the end of each fiscal quarter, a ratio of total debt to total capitalization of no greater than 70 percent. At March 31, 2006, our total-debt-to-total-capitalization ratio, as defined, was 62 percent. In addition, the fees that we pay on unused amounts under both the $600 million and $300 million credit facilities are subject to adjustment depending upon our credit ratings.

Uncommitted credit facilities

On November 28, 2005, AEM amended its $250 million uncommitted demand working capital credit facility to increase the amount of credit available from $250 million to a maximum of $580 million. On March 31, 2006, AEM amended and extended this uncommitted demand working capital credit facility to March 31, 2007.

Borrowings under the credit facility can be made either as revolving loans or offshore rate loans. Revolving loan borrowings will bear interest at a floating rate equal to a base rate (defined as the higher of 0.50 percent per annum above the Federal Funds rate or the lender’s prime rate) plus 0.25 percent. Offshore rate loan borrowings will bear interest at a floating rate equal to a base rate based upon LIBOR plus an applicable margin, ranging from

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

1.25 percent to 1.625 percent per annum, depending on the excess tangible net worth of AEM, as defined in the credit facility. Borrowings drawn down under letters of credit issued by the banks will bear interest at a floating rate equal to the base rate, as defined above, plus an applicable margin, which will range from 1.00 percent to 1.875 percent per annum, depending on the excess tangible net worth of AEM and whether the letters of credit are swap-related standby letters of credit.

AEM is required by the financial covenants in the credit facility to maintain a maximum ratio of total liabilities to tangible net worth of 5 to 1, along with minimum levels of net working capital ranging from $20 million to $120 million. Additionally, AEM must maintain a minimum tangible net worth ranging from $21 million to $121 million, and must not have a maximum cumulative loss from March 30, 2005 exceeding $4 million to $23 million, depending on the total amount of borrowing elected from time to time by AEM. At March 31, 2006, AEM’s ratio of total liabilities to tangible net worth, as defined, was 1.21 to 1.

At March 31, 2006, there were no borrowings outstanding under this credit facility. However, at March 31, 2006, AEM letters of credit totaling $151.8 million had been issued under the facility, which reduced the amount available by a corresponding amount. The amount available under this credit facility is also limited by various covenants, including covenants based on working capital. Under the most restrictive covenant, the amount available to AEM under this credit facility was $174.2 million at March 31, 2006. This line of credit is collateralized by substantially all of the assets of AEM and is guaranteed by AEH.

The Company also has an unsecured short-term uncommitted credit line for $25 million that is used for working-capital and letter-of-credit purposes. There were no borrowings under this uncommitted credit facility at March 31, 2006, but letters of credit reduced the amount available by $4.5 million. This uncommitted line is renewed or renegotiated at least annually with varying terms, and we pay no fee for the availability of the line. Borrowings under this line are made on a when-and-as-available basis at the discretion of the bank.

AEH, the parent company of AEM, has a $100 million intercompany uncommitted demand credit facility with the Company which bears interest at LIBOR plus 2.75 percent. This facility has been approved by our state regulators through December 31, 2006. At March 31, 2006, $65.1 million was outstanding under this facility.

In addition, AEM has a $120 million intercompany uncommitted demand credit facility with AEH for its nonutility business which bears interest at LIBOR plus 2.75 percent. Any outstanding amounts under this facility are subordinated to AEM’s $580 million uncommitted demand credit facility described above. This facility is used to supplement AEM’s $580 million credit facility. At March 31, 2006, $62 million was outstanding under this facility.

Debt Covenants

We have other covenants in addition to those described above. Our Series P First Mortgage Bonds contain provisions that allow us to prepay the outstanding balance in whole at any time, after November 2007, subject to a prepayment premium. The First Mortgage Bonds provide for certain cash flow requirements and restrictions on additional indebtedness, sale of assets and payment of dividends. Under the most restrictive of such covenants, cumulative cash dividends paid after December 31, 1985 may not exceed the sum of accumulated net income for periods after December 31, 1985 plus $9 million. At March 31, 2006 approximately $266.8 million of retained earnings was unrestricted with respect to the payment of dividends.

We were in compliance with all of our debt covenants as of March 31, 2006. If we do not comply with our debt covenants, we may be required to repay our outstanding balances on demand, provide additional collateral or take other corrective actions. Our two public debt indentures relating to our senior notes and debentures, as well as our $600 million and $300 million revolving credit agreements, each contain a default provision that is triggered if outstanding indebtedness arising out of any other credit agreements in amounts ranging from in excess of $15 million to in excess of $100 million becomes due by acceleration or is not paid at maturity. In addition, AEM’s credit agreement contains a cross-default provision whereby AEM would be in default if it defaults on other

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

indebtedness, as defined, by at least $250 thousand in the aggregate. Additionally, this agreement contains a provision that would limit the amount of credit available if Atmos were downgraded below an S&P rating of BBB and a Moody’s rating of Baa2.

Except as described above, we have no triggering events in our debt instruments that are tied to changes in specified credit ratings or stock price, nor have we entered into any transactions that would require us to issue equity, based on our credit rating or other triggering events.


5.	Stock-Based Compensation

Stock-Based Compensation Plans

On August 12, 1998, the Board of Directors approved and adopted the 1998 Long-Term Incentive Plan, which became effective October 1, 1998 after approval by our shareholders. The Long-Term Incentive Plan is a comprehensive, long-term incentive compensation plan providing for discretionary awards of incentive stock options, non-qualified stock options, stock appreciation rights, bonus stock, time-lapse restricted stock, performance-based restricted stock units and stock units to certain employees and non-employee directors of Atmos and its subsidiaries. The objectives of this plan include attracting and retaining the best personnel, providing for additional performance incentives and promoting our success by providing employees with the opportunity to acquire common stock. We are authorized to grant awards for up to a maximum of four million shares of common stock under this plan subject to certain adjustment provisions. As of March 31, 2006, non-qualified stock options, bonus stock, time-lapse restricted stock, performance-based restricted stock units and stock units have been issued under this plan and 1,064,624 shares were available for issuance. The option price of the stock options issued under this plan is equal to the market price of our stock at the date of grant. These stock options expire 10 years from the date of the grant and vest annually over a service period ranging from one to three years.

We used the Black-Scholes pricing model to estimate the fair value of each option granted with the following weighted average assumptions:


	Six Months Ended
	March 31
Valuation Assumptions ⁽¹⁾	2006			2005

Expected Life (years) ⁽²⁾		7			7
Interest rate ⁽³⁾		4.6	%		4.2	%
Volatility ⁽⁴⁾		20.3	%		21.3	%
Dividend yield		4.8	%		4.8	%


⁽¹⁾		Beginning on the date of adoption of SFAS 123(R), forfeitures are estimated based on historical experience. Prior to the date of adoption, forfeitures were recorded as they occurred.

⁽²⁾		The expected life of stock options is estimated based on historical experience.

⁽³⁾		The interest rate is based on the U.S. Treasury constant maturity interest rate whose term is consistent with the expected life of the stock options.

⁽⁴⁾		The volatility is estimated based on historical and current stock data for the Company.

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

A summary of option activity as of March 31, 2006, and changes during the six months then ended, is presented below:


						Weighted-
				Weighted-		Average
				Average		Remaining		Aggregate
	Number of			Exercise		Contractual		Intrinsic
	Options			Price		Term		Value
						(In years)		(In thousands)

Outstanding at September 30, 2005		964,704		$	22.20
Granted		93,196			26.19
Exercised		(2,166	)		20.18
Forfeited		(166	)		21.23

Outstanding at March 31, 2006		1,055,568		$	22.56		5.9	$	3,840

Exercisable at March 31, 2006		1,028,794		$	22.48		5.8	$	3,741

The stock options had a weighted-average fair value per share on the date of grant of $3.74 and $3.69 for the six months ended March 31, 2006 and 2005. There were no stock options granted during the three months ended March 31, 2006 and 2005. Net cash proceeds from the exercise of stock options during the six months ended March 31, 2006 and 2005 were less than $0.1 million and $9.1 million and during the three months ended March 31, 2006 and 2005 were less than $0.1 and $8 million. The associated income tax benefit from stock options exercised during the six months ended March 31, 2006 and 2005 was less than $0.1 million and $1 million, and during the three months ended March 31, 2006 and 2005 was less than $0.1 million and $0.9 million. The total intrinsic value of options exercised during the six months ended March 31, 2006 and 2005 was less than $0.1 million and $1.5 million, and during the three months ended March 31, 2006 and 2005 was less than $0.1 million and $1.3 million.

As of March 31, 2006, there was less than $0.1 million of total unrecognized compensation cost related to nonvested stock options. That cost is expected to be recognized over a weighted-average period of 1.7 years.

Restricted Stock Plans

As noted above, the 1998 Long-Term Incentive Plan provides for discretionary awards of time-lapse restricted stock and performance-based restricted stock units to help attract, retain and reward employees and non-employee directors of Atmos and its subsidiaries. Certain of these awards vest based upon the passage of time and other awards vest based upon the passage of time and the achievement of specified performance targets. The associated expense is recognized ratably over the vesting period.

A summary of the status of the Company’s nonvested restricted shares as of March 31, 2006, and changes during the six months then ended, is presented below:


				Weighted-
	Number of			Average
	Restricted			Grant-Date
	Shares			Fair Value

Nonvested at September 30, 2005		592,490		$	25.32
Granted		83,941			26.19
Vested		(76,190	)		21.33
Forfeited		(1,428	)		25.55

Nonvested at March 31, 2006		598,813		$	25.95

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

As of March 31, 2006, there was $8.8 million of total unrecognized compensation cost related to nonvested restricted shares granted under the 1998 Long-Term Incentive Plan. That cost is expected to be recognized over a weighted-average period of 1.7 years. The total fair value of restricted stock vested during the six months ended March 31, 2006 and 2005 was $1.6 million and $0.5 million, and during the three months ended March 31, 2006 was $1.2 million. There were no restricted stock grants that vested during the three months ended March 31, 2005.


6.	Earnings Per Share

Basic and diluted earnings per share for the three and six months ended March 31, 2006 and 2005 are calculated as follows:


	For the				For the
	Three Months				Six Months
	Ended				Ended
	March 31				March 31
	2006		2005		2006		2005
	(In thousands, except per share amounts)

Net income	$	88,796	$	88,502	$	159,823	$	148,101

Denominator for basic income per share — weighted average common shares		80,573		79,270		80,444		77,290
Effect of dilutive securities:
Restricted and other shares		369		335		369		330
Stock options		98		155		98		149

Denominator for diluted income per share — weighted average common shares		81,040		79,760		80,911		77,769

Income per share — basic	$	1.10	$	1.12	$	1.99	$	1.92

Income per share — diluted	$	1.10	$	1.11	$	1.98	$	1.90

There were no out-of-the-money options excluded from the computation of diluted earnings per share for the three and six months ended March 31, 2006 and 2005 as their exercise price was less than the average market price of the common stock during that period.

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


7.	Interim Pension and Other Postretirement Benefit Plan Information

The components of our net periodic pension cost for our pension and other postretirement benefit plans for the three and six months ended March 31, 2006 and 2005 are presented in the following tables. All of these costs are recoverable through our gas utility rates; however, a portion of these costs is capitalized into our utility rate base. The remaining costs are recorded as a component of operation and maintenance expense.


	Three Months Ended March 31
	Pension Benefits						Other Benefits
	2006			2005			2006			2005
	(In thousands)

Components of net periodic pension cost:
Service cost	$	4,117		$	3,136		$	3,271		$	2,478
Interest cost		5,722			6,017			2,210			2,366
Expected return on assets		(6,400	)		(6,885	)		(547	)		(518	)
Amortization of transition asset		—			1			378			378
Amortization of prior service cost		16			(2	)		90			96
Amortization of actuarial loss		3,299			1,891			320			151

Net periodic pension cost	$	6,754		$	4,158		$	5,722		$	4,951


	Six Months Ended March 31
	Pension Benefits						Other Benefits
	2006			2005			2006			2005
	(In thousands)

Components of net periodic pension cost:
Service cost	$	8,234		$	6,272		$	6,542		$	4,956
Interest cost		11,444			12,034			4,420			4,732
Expected return on assets		(12,800	)		(13,770	)		(1,094	)		(1,036	)
Amortization of transition asset		—			2			756			756
Amortization of prior service cost		32			(4	)		180			192
Amortization of actuarial loss		6,598			3,782			640			302

Net periodic pension cost	$	13,508		$	8,316		$	11,444		$	9,902

The assumptions used to develop our net periodic pension cost for the three and six months ended March 31, 2006 and 2005 are as follows:


	Pension Benefits						Other Benefits
	2006			2005			2006			2005

Discount rate		5.00	%		6.25	%		5.00	%		6.25	%
Rate of compensation increase		4.00	%		4.00	%		4.00	%		4.00	%
Expected return on plan assets		8.50	%		8.75	%		5.30	%		5.30	%

The discount rate used to compute the present value of a plan’s liabilities generally is based on rates of high-grade corporate bonds with maturities similar to the average period over which the benefits will be paid. During the six months ended March 31, 2006, we did not make a voluntary contribution to our pension plans. However, we contributed $5.3 million to our other postretirement plans and we expect to contribute approximately $12 million to these plans during fiscal 2006.

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


8.	Commitments and Contingencies

Litigation and Environmental Matters

With respect to the specific litigation and environmental-related matters or claims that were disclosed in Note 13 to our annual report on Form 10-K for the year ended September 30, 2005, there were no material changes in the status of such litigation and environmental-related matters or claims during the six months ended March 31, 2006. We continue to believe that the final outcome of such litigation and environmental-related matters or claims will not have a material adverse effect on our financial condition, results of operations or net cash flows.

In addition, we are involved in other litigation and environmental-related matters or claims that arise in the ordinary course of our business. While the ultimate results of such litigation and response actions to such environmental-related matters or claims cannot be predicted with certainty, we believe the final outcome of such litigation and response actions will not have a material adverse effect on our financial condition, results of operations or net cash flows.

Purchase Commitments

AEM has commitments to purchase physical quantities of natural gas under contracts indexed to the forward NYMEX strip or fixed price contracts. At March 31, 2006, AEM was committed to purchase 64.2 Bcf within one year, 33.1 Bcf within one to three years and 5.4 Bcf after three years under indexed contracts. AEM is committed to purchase 1.6 Bcf within one year and 0.2 Bcf within one to three years under fixed price contracts with prices ranging from $6.00 to $12.00. Purchases under these contracts totaled $531.8 million and $345.3 million for the three months ended March 31, 2006 and 2005 and $1,319.5 million and $705.4 million for the six months ended March 31, 2006 and 2005.

Our utility operations, other than the Mid-Tex Division, maintain supply contracts with several vendors that generally cover a period of up to one year. Commitments for estimated base gas volumes are established under these contracts on a monthly basis at contractually negotiated prices. Commitments for incremental daily purchases are made as necessary during the month in accordance with the terms of the individual contract.

Our Mid-Tex Division maintains long-term supply contracts to ensure a reliable source of gas for our customers in its service area which obligate it to purchase specified volumes at market prices. The estimated fiscal year commitments under these contracts as of March 31, 2006 are as follows (in thousands):


2006	$	136,543
2007		241,031
2008		121,079
2009		12,022
2010		11,263
Thereafter		37,616

	$	559,554

Regulatory Matters

In February 2005, the Attorney General of the State of Kentucky filed a complaint at the Kentucky Public Service Commission (KPSC) alleging that our present rates are producing revenues in excess of reasonable levels. We answered the complaint and filed a Motion to Dismiss with the KPSC. On February 2, 2006, the KPSC issued an Order denying our Motion to Dismiss and on March 3, 2006 set a procedural schedule for the case. The Attorney General is currently conducting discovery. A hearing should be scheduled for early 2007. We believe that the Attorney General will not be able to demonstrate that our present rates are in excess of reasonable levels.

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In August 2005, we received a “show cause” order from the City of Dallas, which requires us to provide information that demonstrates good cause for showing that our existing distribution rates charged to customers in the City of Dallas should not be reduced. In addition, during the first quarter of fiscal 2006, approximately 80 other cities in the Mid-Tex Division passed resolutions requesting that we “show cause” why existing distribution rates are just and reasonable and required a filing by us on a system-wide basis. We filed our response to these orders during the first quarter of fiscal 2006. Discovery has been conducted by the City of Dallas and the other cities. The 80 cities that acted in the first quarter of fiscal year 2006 have begun adopting resolutions requiring a reduction in the Mid-Tex Division’s residential and commercial rates. We will be appealing these city actions to the Railroad Commission of Texas (RRC) where we believe that we will be able to demonstrate that our rates are just and reasonable.

In November 2005, we received a notice from the Tennessee Regulatory Authority (TRA) that it was opening an investigation into allegations by the Consumer Advocate Division of the Tennessee Attorney General’s Office that we are overcharging customers in parts of Tennessee by approximately $10 million per year. We have responded to numerous data requests from the TRA Staff. On April 24, 2006, the TRA Staff filed a Report and Recommendation in which it recommended that the TRA convene a contested case procedure for the purpose of establishing a fair and reasonable return. The TRA is scheduled to consider the Staff’s recommendation on May 15, 2006. We believe that we are not overcharging our customers, and we intend to participate fully in the investigation.

In January 2006, the Lubbock, Texas City Council passed a resolution requiring Atmos to submit copies of all documentation necessary for the city to review the rates of Atmos’ West Texas Division to ensure they are just and reasonable. Information was provided to the city on February 28, 2006. We believe that we will be able to ultimately demonstrate to the City of Lubbock that our rates are just and reasonable.

Other

On November 30, 2005, we entered into an agreement with a third party to jointly construct, own and operate a 45-mile large diameter natural gas pipeline in the northern portion of the Dallas/Fort Worth Metroplex (North Side Loop). Under terms of the agreement, we are responsible for contributing no more than $42.5 million to the construction costs of the pipeline. We are also responsible for 50 percent of the costs of the compression facilities. Approximately 21 miles of the pipeline was placed in service as of March 31, 2006. The remainder of the pipeline and the associated compressors are expected to be placed in service by the end of May 2006. As of March 31, 2006, we had spent $26.2 million for the North Side Loop project and expect to spend approximately $23.6 million in the remainder of fiscal 2006 for this project.

During the third quarter of fiscal 2005, we entered into two agreements with third parties to transport natural gas through our Texas intrastate pipeline system beginning in fiscal 2006. To handle the increased volumes for these projects, we will install compression equipment and other pipeline infrastructure. We expect to spend approximately $32 million in fiscal 2006 for these projects, which are expected to be in service by the end of the fiscal year.

On August 29, 2005, Hurricane Katrina struck the Gulf Coast, inflicting significant damage to our eastern Louisiana operations. The hardest hit areas in our service territory were in Jefferson, St. Tammany, St. Bernard and Plaquemines parishes. In total, approximately 230,000 of our natural gas customers were affected in these areas. Although service has been restored for many of our customers, a significant number of customers will not require gas service for some time because of sustained damages. We cannot predict with certainty how many of these customers will return to these service areas and over what time period. Additionally, we cannot accurately determine what regulatory actions, if any, may be taken by the regulators with respect to these areas. As of March 31, 2006, we believe adequate provision has been made for any losses that may not be fully recovered through insurance or for which we do not receive rate relief.

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


9.	Concentration of Credit Risk

Credit risk is the risk of financial loss to us if a customer fails to perform its contractual obligations. We engage in transactions for the purchase and sale of products and services with major companies in the energy industry and with industrial, commercial, residential and municipal energy consumers. These transactions principally occur in the southern and midwestern regions of the United States. We believe that this geographic concentration does not contribute significantly to our overall exposure to credit risk. Credit risk associated with trade accounts receivable for the utility segment is mitigated by the large number of individual customers and diversity in our customer base.

Customer diversification also helps mitigate AEM’s exposure to credit risk. AEM maintains credit policies with respect to its counterparties that it believes minimizes overall credit risk. Where appropriate, such policies include the evaluation of a prospective counterparty’s financial condition, collateral requirements and the use of standardized agreements that facilitate the netting of cash flows associated with a single counterparty. AEM also monitors the financial condition of existing counterparties on an ongoing basis. Customers not meeting minimum standards are required to provide adequate assurance of financial performance.

AEM maintains a provision for credit losses based upon factors surrounding the credit risk of customers, historical trends and other information. We believe, based on our credit policies and our provisions for credit losses, that our financial position, results of operations and cash flows will not be materially affected as a result of nonperformance by any single counterparty.

AEM’s estimated credit exposure is monitored in terms of the percentage of its customers that are rated as investment grade versus non-investment grade. Credit exposure is defined as the total of (1) accounts receivable, (2) delivered, but unbilled physical sales and (3) mark-to-market exposure for sales and purchases. Investment grade determinations are set internally by AEM’s credit department, but are primarily based on external ratings provided by Moody’s Investors Service Inc. (Moody’s) and/or Standard & Poor’s Corporation (S&P). For non-rated entities, the default rating for municipalities is investment grade, while the default rating for non-guaranteed industrial and commercial customers is non-investment grade. The following table shows the percentages related to the investment ratings as of March 31, 2006 and September 30, 2005.


	March 31,			September 30,
	2006			2005

Investment grade		42	%		49	%
Non-investment grade		58	%		51	%

Total		100	%		100	%

The following table presents our derivative counterparty credit exposure by operating segment based upon the unrealized fair value of our derivative contracts that represent assets as of March 31, 2006. Investment grade counterparties have minimum credit ratings of BBB-, assigned by S&P; or Baa3, assigned by Moody’s. Non-investment grade counterparties are composed of counterparties that are below investment grade or that have not been assigned an internal investment grade rating due to the short-term nature of the contracts associated with that counterparty. This category is composed of numerous smaller counterparties, none of which is individually significant.


	March 31, 2006
			Natural Gas
	Utility		Marketing
	Segment ⁽¹⁾		Segment		Consolidated
	(In thousands)

Investment grade counterparties	$	13,419	$	11,232	$	24,651
Non-investment grade counterparties		—		4,745		4,745

	$	13,419	$	15,977	$	29,396


⁽¹⁾		Counterparty risk for our utility segment is minimized because hedging gains and losses are passed through to our customers.

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


10.	Segment Information

Atmos Energy Corporation and its subsidiaries are engaged primarily in the natural gas utility business as well as certain nonutility businesses. We distribute natural gas through sales and transportation arrangements to approximately 3.2 million residential, commercial, public authority and industrial customers throughout our seven regulated utility divisions, which cover service areas located in 12 states. In addition, we transport natural gas for others through our distribution system.

Through our nonutility businesses we provide natural gas management and marketing services to industrial customers, municipalities and other local distribution companies located in 22 states. Additionally, we provide natural gas transportation and storage services to certain of our utility operations and to third parties.

Our operations are divided into four segments:


	•	the utility segment, which includes our regulated natural gas distribution and related sales operations,

	•	the natural gas marketing segment, which includes a variety of nonregulated natural gas management services,

	•	the pipeline and storage segment, which includes our regulated and nonregulated natural gas transmission and storage services and

	•	the other nonutility segment, which includes all of our other nonregulated nonutility operations.

Our determination of reportable segments considers the strategic operating units under which we manage sales of various products and services to customers in differing regulatory environments. Although our utility segment operations are geographically dispersed, they are reported as a single segment as each utility division has similar economic characteristics. The accounting policies of the segments are the same as those described in the summary of significant accounting policies found in our annual report on Form 10-K for the fiscal year ended September 30, 2005. We evaluate performance based on net income or loss of the respective operating units.

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Income statements for the three and six-month periods ended March 31, 2006 and 2005 by segment are presented in the following tables:


	Three Months Ended March 31, 2006
					Pipeline
			Natural Gas		and		Other
	Utility		Marketing		Storage		Nonutility		Eliminations			Consolidated
	(In thousands)

Operating revenues from external parties	$	1,447,376	$	564,737	$	21,238	$	495	$	—		$	2,033,846
Intersegment revenues		244		253,892		24,245		1,100		(279,481	)		—

		1,447,620		818,629		45,483		1,595		(279,481	)		2,033,846
Purchased gas cost		1,131,885		774,652		211		—		(278,305	)		1,628,443

Gross profit		315,735		43,977		45,272		1,595		(1,176	)		405,403
Operating expenses
Operation and maintenance		94,363		5,821		12,363		1,361		(1,210	)		112,698
Depreciation and amortization		41,907		475		4,669		25		—			47,076
Taxes, other than income		61,701		348		2,654		93		—			64,796

Total operating expenses		197,971		6,644		19,686		1,479		(1,210	)		224,570

Operating income		117,764		37,333		25,586		116		34			180,833
Miscellaneous income (expense)		155		608		132		1,183		(4,517	)		(2,439	)
Interest charges		30,303		1,997		6,621		1,054		(4,483	)		35,492

Income before income taxes		87,616		35,944		19,097		245		—			142,902
Income tax expense		32,988		14,012		7,010		96		—			54,106

Net income	$	54,628	$	21,932	$	12,087	$	149	$	—		$	88,796

Capital expenditures	$	83,749	$	235	$	26,781	$	—	$	—		$	110,765

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Three Months Ended March 31, 2005

Pipeline

Natural Gas
and
Other

Utility Marketing Storage Nonutility Eliminations Consolidated

(In thousands)

Operating revenues from external parties
$ 1,235,092 $ 429,598 $ 19,827 $ 568 $ — $ 1,685,085

Intersegment revenues
285 83,293 25,719 710 (110,007 ) —

1,235,377 512,891 45,546 1,278 (110,007 ) 1,685,085

Purchased gas cost
912,309 501,731 4,407 — (109,256 ) 1,309,191

Gross profit
323,068 11,160 41,139 1,278 (751 ) 375,894

Operating expenses

Operation and maintenance
86,469 4,016 12,843 893 (801 ) 103,420

Depreciation and amortization
41,181 474 3,642 29 — 45,326

Taxes, other than income
52,220 261 2,398 88 — 54,967

Total operating expenses
179,870 4,751 18,883 1,010 (801 ) 203,713

Operating income
143,198 6,409 22,256 268 50 172,181

Miscellaneous income
1,974 201 292 616 (2,125 ) 958

Interest charges
28,062 679 6,228 179 (2,075 ) 33,073

Income before income taxes
117,110 5,931 16,320 705 — 140,066

Income tax expense
43,459 2,140 5,682 283 — 51,564

Net income
$ 73,651 $ 3,791 $ 10,638 $ 422 $ — $ 88,502

Capital expenditures
$ 63,129 $ 228 $ 6,908 $ — $ — $ 70,265

ATMOS ENERGY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Six Months Ended March 31, 2006

Pipeline

Natural Gas
and
Other

Utility Marketing Storage Nonutility Eliminations Consolidated

(In thousands)

Operating revenues from external parties
$ 2,852,182 $ 1,425,350 $ 39,119 $ 1,015 $ — $ 4,317,666

Intersegment revenues
448 495,124 46,076 2,072 (543,720 ) —

2,852,630 1,920,474 85,195 3,087 (543,720 ) 4,317,666

Purchased gas cost
2,256,714 1,850,178 211 — (541,430 ) 3,565,673

Gross profit
595,916 70,296 84,984 3,087 (2,290 ) 751,993

Operating expenses

Operation and maintenance
187,129 10,173 23,361 2,626 (2,374 ) 220,915

Depreciation and amortization
80,171 945 9,171 49 — 90,336

Taxes, other than income
104,603 591 4,814 204 — 110,212

Total operating expenses
371,903 11,709 37,346 2,879 (2,374 ) 421,463

Operating income
224,013 58,587 47,638 208 84 330,530

Miscellaneous income (expense)
2,992 1,198 1,537 1,844 (9,562 ) (1,991 )

Interest charges
61,891 4,859 12,594 1,815 (9,478 ) 71,681

Income before income taxes
165,114 54,926 36,581 237 — 256,858

Income tax expense
62,073 21,542 13,327 93 — 97,035

Net income
$ 103,041 $ 33,384 $ 23,254 $ 144 $ — $ 159,823

Capital expenditures
$ 156,164 $ 567 $ 56,499 $ — $ — $ 213,230


	Three Months Ended March 31, 2005
					Pipeline
			Natural Gas		and		Other
	Utility		Marketing		Storage		Nonutility		Eliminations			Consolidated
	(In thousands)

Operating revenues from external parties	$	1,235,092	$	429,598	$	19,827	$	568	$	—		$	1,685,085
Intersegment revenues		285		83,293		25,719		710		(110,007	)		—

		1,235,377		512,891		45,546		1,278		(110,007	)		1,685,085
Purchased gas cost		912,309		501,731		4,407		—		(109,256	)		1,309,191

Gross profit		323,068		11,160		41,139		1,278		(751	)		375,894
Operating expenses
Operation and maintenance		86,469		4,016		12,843		893		(801	)		103,420
Depreciation and amortization		41,181		474		3,642		29		—			45,326
Taxes, other than income		52,220		261		2,398		88		—			54,967

Total operating expenses		179,870		4,751		18,883		1,010		(801	)		203,713

Operating income		143,198		6,409		22,256		268		50			172,181
Miscellaneous income		1,974		201		292		616		(2,125	)		958
Interest charges		28,062		679		6,228		179		(2,075	)		33,073

Income before income taxes		117,110		5,931		16,320		705		—			140,066
Income tax expense		43,459		2,140		5,682		283		—			51,564

Net income	$	73,651	$	3,791	$	10,638	$	422	$	—		$	88,502

Capital expenditures	$	63,129	$	228	$	6,908	$	—	$	—		$	70,265


	Six Months Ended March 31, 2006
					Pipeline
			Natural Gas		and		Other
	Utility		Marketing		Storage		Nonutility		Eliminations			Consolidated
	(In thousands)

Operating revenues from external parties	$	2,852,182	$	1,425,350	$	39,119	$	1,015	$	—		$	4,317,666
Intersegment revenues		448		495,124		46,076		2,072		(543,720	)		—

		2,852,630		1,920,474		85,195		3,087		(543,720	)		4,317,666
Purchased gas cost		2,256,714		1,850,178		211		—		(541,430	)		3,565,673

Gross profit		595,916		70,296		84,984		3,087		(2,290	)		751,993
Operating expenses
Operation and maintenance		187,129		10,173		23,361		2,626		(2,374	)		220,915
Depreciation and amortization		80,171		945		9,171		49		—			90,336
Taxes, other than income		104,603		591		4,814		204		—			110,212

Total operating expenses		371,903		11,709		37,346		2,879		(2,374	)		421,463

Operating income		224,013		58,587		47,638		208		84			330,530
Miscellaneous income (expense)		2,992		1,198		1,537		1,844		(9,562	)		(1,991	)
Interest charges		61,891		4,859		12,594		1,815		(9,478	)		71,681

Income before income taxes		165,114		54,926		36,581		237		—			256,858
Income tax expense		62,073		21,542		13,327		93		—			97,035

Net income	$	103,041	$	33,384	$	23,254	$	144	$	—		$	159,823

Capital expenditures	$	156,164	$	567	$	56,499	$	—	$	—		$	213,230


	Six Months Ended March 31, 2005
					Pipeline
			Natural Gas		and		Other
	Utility		Marketing		Storage		Nonutility		Eliminations			Consolidated
	(In thousands)

Operating revenues from external parties	$	2,148,498	$	862,508	$	41,579	$	1,124	$	—		$	3,053,709
Intersegment revenues		560		144,184		47,657		1,513		(193,914	)		—

		2,149,058		1,006,692		89,236		2,637		(193,914	)		3,053,709
Purchased gas cost		1,568,679		968,688		10,628		—		(192,283	)		2,355,712